Thursday, December 25, 2014

Nearly 2,000 years ago a young religious scholar, the son of a carpenter, chose to stand apart from the established religious leaders of the day. Building upon a heritage of moral virtues, he emphasized love for all, including thy enemies, as well as hope and compassion.On this day, December 25, 2014, we are honored to celebrate his birth. In so doing, let us share with each other his message - that good will prevail over evil, that peace can and will be accomplished, and that love will conquer all.Let us also remember his teaching - that understanding and goodwill to all leads to treasures more lasting than any accumulation of gold or silver.May peace, love and kindness find you on this special day. Merry Christmas.

Friday, December 12, 2014

Torture is alleged to be undertaken by the CIA (under authorization, at least to an extent, from someone
in the Bush Administration). While many issues exist, which deserve close examination in the days, weeks, months and years ahead, two issues have found their way into the
discussion of the CIA’s acts:

First, was it torture?

Second, if it was torture, was it
not justified? In other words, do the ends justify the means?

In this blog post I provide an examination of some of the legal authority, as well as a very brief review of ethical theories, with the hope of informing your understanding of these complex issues.

What Were the Acts
Which the CIA Undertook?

While we only have the U.S. Senate Intelligence Report to
rely upon, there appears to be little dispute that the acts that are described
as torture actually took place, at least for some prisoners. The Report states in part:

#3: The interrogations of CIA
detainees were brutal and far worse than the CIA represented to policymakers
and others. Beginning with the CIA's first
detainee, Abu Zubaydah, and continuing with numerous others, the CIA applied
its enhanced interrogation techniques with significant repetition for days or
weeks at a time. Interrogation techniques such as slaps and
"wallings" (slamming detainees against a wall) were used in
combination, frequently concurrent with sleep deprivation and nudity … The
waterboarding technique was physically harmful, inducing convulsions and
vomiting … Sleep deprivation involved keeping detainees awake for up to 180
hours, usually standing or in stress positions, at times with their hands
shackled above their heads. At least five detainees experienced disturbing
hallucinations during prolonged sleep deprivation and, in at least two of those
cases, the CIA nonetheless continued the sleep deprivation.”

Were These Acts
“Torture”?

There are several international treaties that prohibit the
use of torture. An early treaty of applicability is Common Article 3 of the Geneva Conventions, to which the
United States is a signatory, which states in pertinent part:

ARTICLE 3

In the case of armed conflict not of an
international character occurring in the territory of one of the High
Contracting Parties, each Party to the conflict shall be bound to apply, as a
minimum, the following provisions:

(1) Persons taking no active part in the
hostilities, including members of armed forces who have laid down their arms
and those placed ' hors de combat ' by sickness, wounds, detention, or any
other cause, shall in all circumstances be treated humanely, without any
adverse distinction founded on race, colour, religion or faith, sex, birth or
wealth, or any other similar criteria.

To this end, the following acts are and
shall remain prohibited at any time and in any place whatsoever with respect to
the above-mentioned persons:

(a) violence to life and person,
in particular murder of all kinds, mutilation, cruel treatment and torture;

(d) the passing of sentences and
the carrying out of executions without previous judgment pronounced by a
regularly constituted court, affording all the judicial guarantees which are
recognized as indispensable by civilized peoples.

A more recent treaty is the U.N.'s Convention on Torture. In the United States’ report (Oct. 15, 1999) regarding the
United Nations’ Convention against Torture and Other Cruel, Inhuman or Degrading
Treatment or Punishment, which was ratified by the United States in 1994 (subject to certain
reservations and interpretations), the U.S. Department of State wrote:

Torture is prohibited by law
throughout the United States. It is categorically denounced as a matter of
policy and as a tool of state authority. Every act constituting torture under
the Convention constitutes a criminal offence under the law of the United
States. No official of the Government, federal, state or local, civilian or
military, is authorized to commit or to instruct anyone else to commit torture.
Nor may any official condone or tolerate torture in any form … The United
States is committed to the full and effective implementation of its obligations
under the Convention throughout its territory.

The United States conditioned its ratification upon the following
reservation:

[T]he United States considers
itself bound by the obligation under Article 16 to prevent “cruel, inhuman or
degrading treatment or punishment”, only insofar as the term “cruel, inhuman or
degrading treatment or punishment” means the cruel, unusual and inhumane
treatment or punishment prohibited by the Fifth, Eighth and/or Fourteenth
Amendments to the Constitution of the United States.

The U.S. Senate, in approving the Convention Against Torture, in its advice and consent also indicated
that its approval was subject to particular understandings concerning “mental
torture,” a term that is not specifically defined by the Convention. The U.S. Senate stated: "The United
States understands mental torture to refer to prolonged mental harm caused or
resulting from: (1) the intentional infliction or threatened infliction of
severe physical pain and suffering; (2) the administration of mind-altering
substances or procedures to disrupt the victim’s senses; (3) the threat of
imminent death; or (4) the threat of imminent death, severe physical suffering,
or application of mind-altering substances to another."

In 1994, Congress enacted a federal law to implement the
requirements of the Convention against
Torture relating to acts of torture committed outside United States
territory. The statute adopts the Convention’s definition of torture,
consistent with the terms of United States ratification.Torture is therefore defined in U.S.
statutory law (18 U.S. Code §2340): “[A]n act committed by a person acting
under the color of law specifically intended to inflict severe physical or
mental pain or suffering (other than pain or suffering incidental to lawful
sanctions) upon another person within his custody or physical control.”

Of note, a 2009 study of the Guantanamo detainees stated: “[t]wo-thirds
of the former detainees [interviewed] report residual psychological and
emotional trauma.” Laurel E. Fletcher & Eric Stover, The Guantanamo Effect:
Exposing The Consequences Of U.S. Detention And Interrogation Practices
(2009).

Can we conclude that the actions described in the U.S.
Senate Intelligence Committee’s report, such as waterboarding, sleep
deprivation, and “walling,” constitute “torture”? To this I would also ask,
“How could rationale men and women conclude otherwise?”

But, Even if the Acts Were Torture, Was the Torture
Justified?

According to the U.S. Senate Intelligence Committee Report,
“These techniques were approved because Bush Administration lawyers and
officials were told, and believed, that these coercive interrogations were absolutely necessary to elicit
intelligence that was unavailable by any other collection method and would save
American lives.” [Emphasis added.] To
put it more simply, it is argued that torture was justified if it was necessary to save lives. In essence, the ends justified the means.

The key is the word “necessary.” As a society we accept that
one might harm another in very limited circumstances. The "doctrine of necessity" applies when an illegal or harmful behavior may be used to prevent or correct a
greater harm. It provides a legal justification for the necessary action,
allowing people to avoid or reduce liability.

For example, one might act in self-defense, where no
reasonable avenue exists to evade and flee, to save one’s own life from an
assailant. But, can we extend this
“doctrine of necessity” or “doctrine of self-preservation” to justify torture?

There exist ethical theories under which the "doctrine of necessity" can be examined.

Contrasting
Utilitarianism with Natural Rights Theory

Under the ethical theory of utilitarism, the
consequentialist theory of torture states that torture may be acceptable or
even mandated if society receives a net benefit that outweighs the harm of
torture. Under this theory we must consider not just the harm experienced by
the individual victim but also by society in general. The “greatest good” then
prevails. Hence, for those who follow this ethical view, the “doctrine of
necessity” could exist.

But, under natural rights theory – an ethical theory that
all men and women possess certain natural rights that cannot be violated
without their consent – a near-absolute ban on torture exists. Under this
theory, no conduct, no matter how deplorable, will permit torture. This view
generally follows Kantian philosophy. Accordingly, under natural rights theory
the “doctrine of necessity” cannot be used to justify torture, as each
individual’s rights inviolable even in extreme circumstances.

View of the U.S.
State Department: Torture Cannot Be Justified, Even Under "Exceptional Circumstances"

In the U.S. State Department 1999 Report on the Convention on Torture, the State
Department wrote:

No exceptional circumstances may be
invoked as a justification of torture. United States law contains no provision
permitting otherwise prohibited acts of torture or other cruel, inhuman or
degrading treatment or punishment to be employed on grounds of exigent
circumstances (for example, during a “state of public emergency”) or on orders
from a superior officer or public authority, and the protective mechanisms of
an independent judiciary are not subject to suspension.

By implication, therefore, the U.S. State Department
appeared to have previously negated the applicability of the doctrine of
necessity as justification for torture.

Examining the “Doctrine
of Necessity” via a Shipwreck, Lifeboat, Murder and Cannibalism

An early legal precedent from England examines the "doctrine of necessity."

An 1884 English case examined the “doctrine of necessity” in
the context of a shipwreck in which several survivors found themselves in a
lifeboat, in desperate straights. Two sailors, adrift in a lifeboat at sea for
several weeks, and without food or water for eight straight days, “were subject
to terrible temptation, to sufferings which might break down the bodily power
of the strongest man, and try the conscience of the best … [the two sailors]
put to death a weak and unoffending boy upon the chance of preserving their own
lives by feeding upon his flesh and blood after he was killed, and with the
certainty of depriving him, of any possible chance of survival.”

Chief Justice Lord Coleridge, delivering the opinion of the
Court, stated: “Now it is admitted that the deliberate killing of this
unoffending and unresisting boy was clearly murder, unless the killing can be
justified by some well-recognised excuse admitted by the law … the temptation
to the act which existed here was not what the law has ever called necessity.
Nor is this to be regretted. Though law and morality are not the same, and many
things may be immoral which are not necessarily illegal, yet the absolute
divorce of law from morality would be of fatal consequence; and such divorce
would follow if the temptation to murder in this case were to be held by law an
absolute defence of it. It is not so. To preserve one's life is generally
speaking a duty, but it may be the plainest and the highest duty to sacrifice
it. War is full of instances in which it is a man's duty not to live, but to
die. The duty, in case of shipwreck, of a captain to his crew, of the crew to
the passengers, of soldiers to women and children, as in the noble case of the
Birkenhead; these duties impose on men the moral necessity, not of the
preservation, but of the sacrifice of their lives for others from which in no
country, least of all, it is to be hoped, in England, will men ever shrink, as
indeed, they have not shrunk. It is not correct, therefore, to say that there
is any absolute or unqualified necessity to preserve one's life … It is not
needful to point out the awful danger of admitting the principle which has been
contended for. Who is to be the judge of this sort of necessity? By what
measure is the comparative value of lives to be measured? Is it to be strength,
or intellect, or 'what? It is plain that the principle leaves to him who is to
profit by it to determine the necessity which will justify him in deliberately
taking another's life to save his own. In this case the weakest, the youngest,
the most unresisting, was chosen. Was it more necessary to kill him than one of
the grown men? The answer must be ‘No’ … it is quite plain that such a
principle once admitted might be made the legal cloak for unbridled passion and
atrocious crime.” [Emphasis added.] The Queen v. Dudley and
Stephens (December 9, 1884).

In Conclusion

This brief post is not intended as a full examination of the
ethical theories and legal precedents as to whether torture, in the face of
terrorism, can be justified. Rather, the theories and legal authority set forth
above are offered merely to assist others in framing a few aspects of the
debate.

You might like to believe that the natural rights
theory, seemingly applied in the Dudley &
Stevens case, would be adopted by you. You might believe that you would respect the
inalienable human rights men and women possess and that you would not engage in torture.

But are you so
certain?

Suppose a terrorist was caught. The terrorist has planted a
bomb in your city, which will destroy your city and everyone in it. There is
not enough time to evacuate the entire town – perhaps only a third could escape
the blast in the few hours remaining.

Thousands and thousands (if not hundreds of thousands) of
your fellow citizens will likely lose their lives to the massive bomb that is
ticking, should it explode. Your spouse, and your children (or grandchildren)
are among those likely to lose their lives. As well as your brother, sister, nieces and nephews.

You are in charge of the interrogation of the terrorist, who
has refused to answer your questions thus far. Three hours remain. What would you do?

Monday, December 8, 2014

There are many ways to determine valuations of individual stocks, and then by extrapolation the valuation levels of asset classes or the overall U.S. stock market. Some measures, however, such as P/E ratios, are highly volatile and can at times yield valuation measures which are even, at times, nonsensical. CAPE is, in my view, a better way of determining price on the basis of earnings, given that earnings are smoothed over a decade, although as many have written various adjustments may (or may not) need to be undertaken for CAPE.

Other measures of valuation tend to incorporate yields on U.S. Treasury bills, notes or bonds. While there is much intellectual underpinning to this approach, if you are a short-term investor, I am suspect of the introduction of bond yields into equity valuation models for purposes of a very long-term (15 year or more) investor. Over any 15-year period yields can tremendously vary.

For over a decade I've primarily relied upon price-book ratios to provide me a sense of how overvalued, or undervalued, the U.S. stock market may be. Why? First, for the Russell 1000 and 2000 indexes (growth, balanced and value) I've been able to reconstruct an estimate of the average p/b ratio, going back to 1977. This gives us 34 years of data to come up with an average. Second, p/b ratios for Russell indexes are provided monthly, giving us fairly up-to-date measures. Third, book values don't fluctuate wildly over the short term.

Of course, there are downsides to the utilization of price-book ratios. Since 1977 the U.S. economy has moved substantially away from capitalization-intensive industries and toward service industries. As part of this evolution, new industries have substantially grown, such as computer software, which are not very capital intensive. And many companies have outsourced their manufacturing to companies in China, the Phillippines, Indonesia, or other countries, thereby lowering the book equity. Hence, one can argue that the "mean" for price-book ratios should be higher than the "1977-2013 Estimated Average P/B Ratio" shown below.

Current (12/7/2014) valuations of U.S. stock asset classes
are as follows, based

upon price-book measures of these asset class relative to
1977-2013 norms,

with further adjustments reflecting 11/1/2014-12/5/14 returns:

ASSET
CLASS

10.31.14
P/B Ratio

P/B Ratio after 11/1-12/5/14 returns adjustment

1977-2013

Est. Avg.
P/B Ratio

Percent Overvaluation /
(Undervaluation)

Relative to Estimated Average P/B Ratios

Resulting Adjustment to Asset
Class Historical Rate of Return

U.S. Large Cap Growth

5.26

5.42

4.0

35%

-2.1%

U.S. Large Cap Balanced

2.75

2.83

2.3

23%

-1.4%

U.S. Large Cap Value

1.84

1.89

1.6

24%

-1.4%

U.S. Small Cap Growth

4.11

4.15

3.2

30%

-1.8%

U.S. Small Cap Balanced

2.24

2.26

1.8

26%

-1.5%

U.S. Small Cap Value

1.54

1.56

1.3

20%

-1.2%

Source: Data based upon Russell Indexes for
U.S. stock asset classes, and Vanguard funds monthly/MTD data, as accumulated
and analyzed by ScholarFi Inc. All measures of overvaluation/undervaluation are
estimates, only. An adjustment is then made to available month-end data,
derived from Russell Index data site, for changes in prices over subsequent
period to date shown. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RETURNS. For educational purposes only. No warranties are provided as to the accuracy of the data provided.

The last column in the chart above reflects an adjustment to estimated average rates of return for the asset class, should reversion to the mean occur over a 15-year period.

Just because the stock market is "overvalued" does not mean that valuations cannot go much higher. In fact, following are the "low" and "high" markets of the valuations for the foregoing asset classes during the 1977-2013 era (with 12/6/2014 "current" estimated valuations shown again, for comparison purposes):

ASSET
CLASS

Lowest
P/B Ratio (Month/Year)

Current Estimated

P/B Ratio
(12/5/2014)

Highest P/B.
Ratio (Month/Year

U.S. Large Cap Growth

2.06 (12/1978)

5.42

11.00 (12/1999)

U.S. Large Cap Balanced

1.23 (12/1978)

2.83

5.21 (12/1999)

U.S. Large Cap Value

0.87 (12/1978)

1.89

3.31 (12/2000)

U.S. Small Cap Growth

1.73 (12/1978)

4.15

5.77 (12/1999)

U.S. Small Cap Balanced

0.99 (12/1978)

2.26

2.72 (12/1999)

U.S. Small Cap Value

0.69 (12/1979)

1.56

2.11 (12/1997)

Source: Data based upon Russell Indexes for
U.S. stock asset classes, as accumulated and analyzed by ScholarFi Inc. All
measures of overvaluation/undervaluation are estimates, only. An adjustment is
then made to available month-end data, derived from Russell Index data site,
for changes in prices over subsequent period to date shown, using Vanguard
funds data.

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RETURNS. For educational purposes only. No warranties are provided as to the accuracy of the data provided.

Where does all of the foregoing leave us? Permit me to share a few of my own conclusions:

First, I believe that the U.S. stock market has likely reached a point of overvaluation, relative to historic norms. Perhaps in the range of 0% to 40% overvalued. (The data, for the reasons stated above, does not permit in my view a closer approximation of values.)

Second, if you tilt your U.S. equity allocation in your portfolios toward value and small-cap stocks (on a diversified basis), it does not appear that value and small-cap stocks are as significantly overvalued as large-cap growth stocks might be. Hence, some comfort should be taken that the value and small cap risk premia are likely to deliver, with a high degree of probability (but not certainty), higher returns in the U.S. equity portion of a portfolio over the long term (15 years or longer).

Third, I don't believe that valuation levels have reached such stellar heights that investors should flee the U.S. stock market, nor any particular asset class. (I'm not convinced that "market timing" in the form of "tactical asset allocation" can consistently add value, over and above a consistent exposure to the value and small cap risk premia.)

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About the Author

Ron A. Rhoades, JD, CFP® sailed across the Atlantic on a tall ship, performed in theme parks and road shows in Europe and America as a Disney character, rowed on a championship crew team, marched in the Macy’s Thanksgiving Day Parade, marched in competition with a state-champion rifle drill team, undertook a solo one-week trip into the Everglades, escorted numerous celebrities around Central Florida, performed as a “Tin Man” at a mountaintop theme park called “The Land of Oz” in Beech Mountain, NC, and served as a stage manager and talent scheduling coordinator for entertainment productions at Walt Disney World. And then he graduated college.

Since then, Ron Rhoades earned his Juris Doctor degree, with honors, from the University of Florida College of Law, which was preceded by a B.S.B.A. from Florida Southern College. Ron Rhoades has 30 years of experience as an attorney, with nearly all of those years substantially devoted to estate planning, tax planning, and retirement plan distribution planning. Ron also has over 15 years as a personal financial adviser. He was a principal with an investment advisory firm where he served as its Director of Research and Chair of its Investment Committee.

The author of numerous articles published in financial industry publications and several books, Dr. Rhoades has been quoted in numerous consumer and trade publications, and has been interviewed on Bloomberg's "Masters in Business" radio show segment. He writes occasional articles for industry publications. Ron is a frequent speaker at local FPA chapter meetings and national conferences in the financial planning and investment advisory professions.

Ron Rhoades was the recipient of The Tamar Frankel Fiduciary of the Year Award for 2011, from The Committee for the Fiduciary Standard, as he “altered the course of the fiduciary discussion in Washington.” He was also named as one of the Top 25 Most Influential persons associated with the investment advisory profession in 2011 by Investment Advisor magazine, and was voted to the “Sweet 16 Most Influential” in Wealth Management’s 2013 “March Madness” competition. Dr. Rhoades was also named as one of the "Top 30 Most Influential" members in NAPFA's 30-year history in 2013. This blog was also called one of the "Top 25 Most Dangerous" in financial services.

Ron A. Rhoades, JD, CFP® became Program Director for the Financial Planning Program (B.S. Finance, Financial Planning Track) at Western Kentucky University's Gordon Ford School of Business in July 2015. He provides instruction to highly motivated, exceptional undergraduates students in such courses as Applied Investments, Retirement Planning, Estate Planning, and the Personal Financial Planning Capstone course. He has previously taught courses in Insurance & Risk Management, Employee Benefits, Money & Banking, Advanced Investments, and Business Law I and II.

Ron also serves on the Steering Committee of The Committee for the Fiduciary Standard, on whose behalf he frequently travels to Washington, D.C. to meet with policy makers in Congress and in government agencies regarding the application of the fiduciary standard to personalized investment advice.